There are three financial statements that provide a picture of the financial health of your business:

  1. The Balance Sheet shows what the business has and what the business owes, along with its net worth
  2. The Income Statement is used to give a summary of the company’s revenue and expenses over a period of time
  3. The Statement of Cash Flows shows how changes in the balance sheet accounts and income affect cash and cash equivalents

While all business owners are familiar with their income statement, or P&L, and some business owners look at their balance sheet, very few understand the importance of the statement of cash flows. The statement of cash flows, while sometimes difficult to understand, tells a lot about the health of your company.

The statement of cash flows breaks down to 3 types of activities:

  1. Operating
  2. Investing
  3. Financing

The operating section of the statement of cash flows focuses on the cash inflows and outflows from your company’s main business activities of buying and selling merchandise, providing services, etc.  If business operations are showing negative cash flows you should look at:

  • your gross profit
  • the timeliness of collecting accounts receivable
  • how much cash is tied up in inventory.

The investing section of the statement of cash flows shows the outflows and inflows related to the purchase and sale of equipment and other fixed assets.  Negative cash flow from investing is not necessarily a bad thing, it is an indication that the company is upgrading.

The financing section of the statement of cash flows shows the inflows and outflows of cash resulting from debt, issuance/re-purchase of company stock, and dividend payments/distributions.  Positive financing cash flow could be a result of business operations being negative or an increase of investing activities.  If the company is seeing an increase of financing due to the negative cash flow of operations this is red flag and should be analyzed.

Without a cash flow statement, it may be difficult to have an accurate picture of a company’s performance. The income statement will tell you how much interest you paid on a loan and the balance sheet will tell you how much you owe, but only the cash flow statement will tell you how much cash was consumed servicing that loan. The income statement will record sales and profits but it’s the cash flow statement that will alert you if those sales aren’t generating enough cash to cover expenses.

We at Mackey Advisors are committed to helping entrepreneurs build better businesses. If you need assistance understanding your statement of cash flows, or any of your financial statements please give us a call at 859.331.7755, we’d be happy to help!